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It is ridiculous to depreciate an investment property
I don't have a problem with showing investment properties at their historical cost, for the sake of simplicity, but I do have a problem with depreciating them. It is quite ridiculous to charge depreciation on an asset which is appreciating in value.
Also, for many properties is will be impossible to separate the cost of the land from the cost of the building. And how do you determine the estimated useful life of a building which is already over 100 years old?
We have an investment property which was bought in 1962 for about £16,000 and is now worth over £200,000. I am happy to accept, for simplicity, that it should just be shown at its original cost of £16,000. But I'd just have to guess how much of the cost related to the building. And if I then calculated depreciation at 2% per year, the written down value of the building would be nil.
Is is possible to justify an argument that the depreciation of the building should be nil, because its estimated useful life is more than 50 years, and its estimated residual value is more than cost?
Agreed it's nonsensical
Last week I attended a free local seminar on all of this. I did think common sense had prevailed as the speaker told us that the decision to withdraw the revaluation method for investment properties had been reversed and a previous valuation could be used on transition. She did not say where this information was but I've looked at FRS 105and it seems not to be the case so I think she was wrong - moreso judging by this article.
Personally I think this micros regime is a disaster waiting to happen.
What % of micro companies are property investment?
It's accepted by the standard setters that ME accounts format won't suit all situations, so the grief expressed above is self imposed, FRS102 suits far better, so use it.
For my trading ME companies the new standard is a godsend, making the stat accounts the equivalent of a VAT return, with management accounts providing value in running the business.
FRS 102 does not suit better. The property investment company I am referring to is a very small family company, and its accounts are very simple, and FRS105 would be ideal apart from the need to do the contrived depreciation calculations described above.
The company also has interest-free loans from the directors, and FRS102 would require some complicated calculations of the "present value of future cash flows", which would just confuse the shareholders (see http://www.icaew.com/en/members/practice-resources/icaew-practice-suppor...).
FRS105 would be far more suitable, and I intend to use it, as it will avoid the need to keep revaluing the properties and calculating deferred taxation, and it will allow me to just show the interest-free loans at the amount outstanding on the loan.
However, there is a very real practical problem with the depreciation calculations on the properties, and if the standard setters want to simplify the accounts, it would be better to allow freehold investment properties to just be stated at cost, without any depreciation, provided that they have an estimated useful life in excess of 50 years, and provided that their net realisable value is greater than the cost.
Investment property depreciation
What is the life of an investment property? We all opt for 50 years, but the simple fact of the matter is that buildings do not fall down when they reach their 50th birthday. It is more likely that the building will still be standing and will still be marketable and, in all probability, at a price higher than its original cost. As depreciation is applied to write tangible fixed assets down to their recoverable amount, where that recoverable amount is higher then there will be no depreciation.
I suspect that this will be one of the very few instances where FRS 105 may prove advantageous.
Residual Value
I am not sure if I am missing something but from a depreciation point of view nothing appears to have changed for fixed assets.
Therefore depreciation is calculated as cost, less residual value and then spread across the useful life. Certainly looking at FRS105 this does not appear to have changed. If your investment property has a residual value equal to its cost then the depreciation amount charged is zero.
Obviously the cost is still reduced because revaluations are not allowed but surely what I have stated above allows some scope to avoid depreciation charges.
Hmmm
Not sure it's as easy as that in honesty. What if property prices are lower when you come to sell. You'd need a fairly accurate residual value each year I think based on property values which to me is more costly in itself! No thank you.
Reading the above ....
I have a feeling its going to end up in a right mess, and amendments will have to be made to FRS 105, who fancies preparing a set of accounts under FRS 105 first.
Useful life!
Interesting that the examples quoted regarding freehold property refer to a useful life example of 50 years. The company that owns the freehold of the property I live in acquired it in the early 1980s and has carried it at cost all that time. The amount is pretty insignificant at just over one and a half thousand pounds. The building has been in existence for 160 years and has leaseholds with just under 60 years to run and the lessees can extend for as long as they wish. The insurance value for replacement and attendant costs exceeds £1 million. So just where does one allocate a fair value to the land as a proportion of the purchase cost? It seems to me that the standard has tried to be too clever with regard to land and buildings. Factories may be demolished or extensively renovated but that is an unusual proposition for residential buildings. To be honest I haven't the faintest idea of the land value and as the house is listed any voluntary changes such as rebuilding would be robustly resisted. So I think I will just continue to carry the original cost with a covering note. I'm fairly sure anyway that the cost of the land exceeds the carrying cost. As for premiums on leases I'm not even going to go there.
FRS 105 + Shares
small SME for which FRS105 would suit - similarly has a smal share 'listed co' share portfolio which it writes down diminution in value ie CR BalSheet provision on listed equity holdings DR P&L
so- what woud happen in adopting FRS 105 -??
would the full provision need to be reversed on transiton [ restate 2015 accounts comparative for year end 2016 stats ] If so the ASSET of portfolio stocks would / could be materially overstated
nb- holding a small share portfolio is not the main business activity
so reverse or not under FRS 105?
I've just seen this article when I searched for this exact question - FRS 105 applying depreciation to investment properties when residual value will be the same if not higher than cost. Has anyone prepared their first set of accounts under FRS 105 with Investment Properties yet? And if so, did you depreciation or do you think non depreciation is an option with a disclosure as to the reason?
Don't lose sight of the fact that it is only the building that is depreciated. It is often the case that the land value escalates leaving the building with a much lower residual value. Hmmm, food for further thought.
Steve - with IFRS15 on revenue recogition wef 1/1/18 etc - how does this now apply - if @ all [to frs105 investment companies] who may be offering rent free/ reduced rent but requiremnt to carry out 'refurb' etc and other issues on recognition ?
Accounts in progress (FRS 105 - Balance Sheet criteria ok due to mortgage) with a leasehold buy-to-let portfolio which has recently seen a market value reduction.
Would have agreed with no depreciation because the residual value would not be lower than purchase price - but it looks like we're going the impairment route anyway.
Obviously no land value to factor in.
A revaluation reserve will be removed also - but do we keep prior year as is and adjust this year, or restate prior year?
Hi, did anyone come to a conclusion on this discussion and create micro accounts for any property investment company?
Did people just use cost at time of purchase and then depreciated the amount. Freehold would be 2% and leasehold would be life of the lease?
Plus when directors invested money into company to purchase property as investments you just pushed this as a loan (any interest added?) Or provided shares.
Any other issues anyone is aware of as no revaluation allowed.
Hi, did anyone come to a conclusion on this discussion and create micro accounts for any property investment company?
Did people just use cost at time of purchase and then depreciated the amount. Freehold would be 2% and leasehold would be life of the lease?
Plus when directors invested money into company to purchase property as investments you just pushed this as a loan (any interest added?) Or provided shares.
Any other issues anyone is aware of as no revaluation allowed.